Visualized: The Top Five Questions on Sustainable Investing

Today, the surge in green investing has been compared to the dot-com boom of the 2000s.

Back then, the internet was anticipated to radically reshape economies. Many companies fell to the wayside, and now 20 years later, tech stocks currently make up roughly 40% of the S&P 500 by market capitalization. Like the dot-com era, green firms are projected to structurally change the way businesses function.

Given the rising interest in green assets, this infographic from MSCI answers the most important questions advisers need answered on sustainable investing.

1. Which type of sustainable investing is right for my client?

First, let’s start with the basics—understanding the terms used to describe sustainable investing:

• Sustainable investing: An umbrella term that typically refers to all types of sustainable, impact, and environmental, social, and governance (ESG) integration approaches
• Impact investing: A type of investing approach that generates measurable social or environmental benefits
• Socially responsible investing (SRI): An investing approach that aligns with an investor’s ethical, religious, or personal values, while actively reducing negative environmental or social consequences
• ESG integration: Considers material environmental, social, and governance factors to enhance long-term risk adjusted returns through its investment approach
• Climate investing: Looks to reduce exposure to climate risk, identify low-carbon investment opportunities, or align portfolios with “net-zero” climate targets

Knowing the key terms of the sustainable landscape allows advisers to more accurately address client objectives, goals, and beliefs.

2. How can I start a conversation with clients about ESG?

Begin by asking what motivates clients. Typically, motivations fall into one of three core objectives:

• Can ESG factors improve my risk-adjusted returns?
• Can I have a positive impact on society through my investments?
• Are my investments consistent with my ethical, political, or religious beliefs?

Client priorities could include financial returns, impact, values, or a combination. Once these have been established, investors can choose from a universe of funds and investment vehicles that more strongly align with their goals.

3. What is ESG data and why is it important?

At the heart of ESG-focused strategies is data. In some cases, ESG analysis of companies is based on over 2,000 data points from a wide cross-section of sources. For MSCI ESG Research, they fall within these three categories:

• Mandatory company disclosures: 20%
• Voluntary company ESG disclosure: 35%
• Alternative data: 45%

Alternative data commonly makes up 45% of the total ESG dataset—constituting far beyond what a company publicly discloses. Still, ESG data can seem vague or elusive. But this doesn’t have to be the case. Rather, ESG data can be broken down and obtained from the following five sources:

• Company filings: Shareholder results, voluntary ESG disclosures
• Non-governmental organizations (NGOs): Global Reporting Initiative (GRI), Task Force on Climate-related Financial Disclosures (TCFD), UN Sustainable Development Goals
• Government: U.S. Environmental Protection Agency (EPA), European Central Bank (ECB)
• Media sources: Major headlines
• Alternative data: Geo mapping, water scarcity data, flood risk analysis

Importantly, after ESG analysts identify the risks and opportunities most relevant to a company, multiple data points coalesce to inform a company’s ESG profile.

4. Why are environmental risks becoming more important?

Rising global temperatures and ecological disruptions pose imminent risks to humanity.

Along with this, other future risks could include: eroding shareholder value, blocked project proposals, regulation compliance costs, and higher borrowing costs. In response, national, corporate, and investor commitments to achieving net-zero emissions in alignment with the Paris Agreement have proliferated.

How does this affect the risk-return profile of investments?

According to research, climate change could erase $7.75 million in value over five years from a hypothetical $100 million portfolio that shared similar returns and volatility over a five-year period to the median global developed market fund as of December, 2019.

5. Will the consideration of ESG in a portfolio lead to underperformance?

Let’s turn our attention to performance, one of the most pressing questions surrounding ESG.

Companies with strong ESG profiles have an MSCI ESG rating of AAA or AA, meaning they lead their industry in managing the most significant ESG risks and opportunities. Studies show that companies with better ESG ratings have illustrated stronger performance, higher dividend payouts, and stronger earnings stability historically, on average.

They have also illustrated the following attributes:

• Lower cost of capital
• Less exposure to systemic risk
• Lower volatility
• Higher profitability

In addition, companies with strong MSCI ESG ratings may possess greater resilience. Stocks with high MSCI ESG ratings have had lower financial drawdowns during crises compared to their market-capitalization-weighted parent index.

Sustainable Investing: Shaping the Dialogue

Companies with higher environmental risks—including heavy carbon polluters, waste emitters, and poor water management—are facing greater scrutiny. At the same time, client demand is shifting to ESG, and the conversation is changing.

These questions can serve as a launching point for advisers to help clients seize new opportunities and mitigate investment risks.

Fact Check: The Truth Behind 5 ESG Myths

In 2021, investors continue to embrace environmental, social, and governance (ESG) investments at record levels.

In the first quarter of 2021, global ESG fund inflows outpaced the last four consecutive quarters, reaching $2 trillion. But while ESG gains rapid momentum, the CFA Institute shows that 33% of professional investors surveyed feel they have insufficient knowledge for considering ESG issues.

To help investors understand this growing trend, this infographic from MSCI helps provide a fact check on five common ESG myths.

1. “ESG Comes at the Expense of Investment Performance”

Fact Check: Not necessarily

Worldwide, ESG-focused companies have not only seen higher returns, but stronger earnings growth and dividends.

Source: MSCI ESG Research LLC (Dec, 2020)
*Contribution of earnings growth and dividends/buybacks to active return
**Active return is the additional gain or loss compared to it respective benchmark

In fact, a separate study from the CFA Institute shows that 35% of investment professionals invest in ESG to improve their financial returns.

2. “Investors Talk About ESG But Don’t Invest In It”

Fact Check: False

Global ESG assets under management (AUM) in ETFs have grown from $6 billion in 2015 to $150 billion in 2020. In just five years, ESG AUM have accelerated 25 times.

Today, money managers are focusing on the following top five issues:

Source: US SIF Foundation (Nov, 2020)

Meanwhile, over 1,500 shareholder resolutions focused on ESG-related matters were filed between 2018-2020. Not only are investors turning to ESG assets, but they are placing higher demands on corporate responsibility.

3. “ESG Investment Strategies Eliminate Entire Sectors”

Fact Check: Not necessarily

First, not all ESG investment approaches are exclusionary.

For instance, in North America roughly 51% of ESG ETFs used an ESG integration approach as of Dec. 31, 2020. In an ESG integration approach, ESG risks and opportunities are analyzed with the goal to support long-term returns.

By comparison, values and screens approaches, which accounted for over 22% of ESG ETFs in North America may screen out specific business activities, such as alcohol or tobacco, or sectors such as oil & gas.

Source: Refinitiv/Lipper and MSCI ESG Research LLC as of Dec 31, 2020 (MSCI Feb, 2021)

Second, companies are assessed on a sector-specific basis where ESG leaders and laggards are identified within each sector in comparison to peers. In other words, ESG doesn’t mean eliminating exposure to entire sectors. Instead, investors can choose from a range of companies based on their ESG ratings quality.

4. “ESG Investing Is Only For Millennials”

Fact Check: False

Although ESG is popular among millennials, ESG investing is being driven by the entire investor population. In 2019, one study finds that 85% of the general population expressed interest in ESG investing.

Source: US SIF Foundation (Nov, 2020)

Sustainable investing goes far beyond millennials—ESG disclosures are quickly becoming requirements for key industry participants, such as institutional investors and listed companies.

5. “ESG Investing is Here to Stay”

Fact Check: True

Climbing 28% in 2020 alone, over 3,000 signatories have committed to the UN Principles of Responsible Investment. As of the first quarter of 2021, 313 global organizations and 33 asset owners have been newly added.

Source: UN PRI
*As of Mar, 2020

Central to ESG’s growth is the availability of ESG investments. ESG investing has become more widely accessible—which wasn’t always the case. Over the last decade, the global number of ESG ETFs has grown from 46 to 497.

Why the Facts Matter

As ESG investments continue to play an even greater role in investor portfolios, it’s important to focus on data rather than prevailing ESG myths that are not backed by fact.

Given the recent momentum in investment returns and ESG adoption, data-driven evidence empowers investors to build more sustainable portfolios that better align with their investment objectives.